Hilary Kramer’s new book, The Little Book of Big Profits from Small Stocks,  focuses on how to find great stocks for under $10.  In the interview below, Hilary talks with Dave Gilbert, editor of Breakout Stocks Under $5, about some of the strategies she recommends for investors, as well as some of her favorite low-priced stocks.

How do you define low-priced stocks, and why do you find them to be such an attractive investment opportunity for individual investors?

Given the recent market sell-offs, there are an incredible number of low-priced stocks now “on sale.” Generally speaking, I could characterize some of the best low-priced stock as those that sell for $10 or less. Of course there are some good stocks that may be trading for more than $10 but are still “low priced” in comparison to where they once were.

Either way, many of these stocks are cheap because they deserve to be — they may dogs that never had potential, or have misstepped so badly that they have no hope of getting back on track. But, many are diamond-in-the-rough companies with the potential to “break out.”

After two decades of investing, I can tell you that choosing the right low-priced stocks is a groundbreaking way to build, or rebuild your wealth. Many of my biggest winners over the years started out as low-priced — stocks like Priceline (NASDAQ:PCLN; up 387%), Starbucks (NASDAQ:SBUX; up 300%), Sirius (NASDAQ:SIRI; up 136%) and Zale’s (NYSE:ZLC; up 100%) — before the big money on Wall Street caught on and sent them soaring.

Once a low-priced stock begins to “break out,” it’s fueled by the snowball effect that kicks in as institutions pile in and drive the share prices of these stocks higher and higher. That’s when we, as investors, can make a lot of money.  It comes down to picking those low-priced stocks with the greatest potential.

You mentioned Sirius XM Radio (NASDAQ:SIRI) as one of your past winners. At just under $2 today, Sirius has to be one of the most talked-about low-priced stocks. Is SIRI a stock that investors should buy?

Not anymore. In my Breakout Stocks Under $5 newsletter, we doubled our money on SIRI and then sold out of it around $2.40. I think we’re already moving toward the next generation of cable-based and Internet-based radio services, many of which are either totally free or have a free version. Plus there are other options for customized music that are gaining momentum quickly. Just look at the Pandora model.

For Sirius, I think there’s a real question of whether their model still works. Is advertising revenue for subscription radio enough to keep paying the costs of expensive talent and production, especially with the company’s debt? To me, the answer isn’t certain enough to invest in the stock.

Your book makes a compelling case for rolling up your sleeves and doing some in-depth research to find the best low-priced stocks.  What financial sites do you visit every day?  And what are your favorite stock screening tools?

Let me start my answer by saying that I think it’s fantastic that individual investors have such great tools at their fingertips to really dig into companies and analyze stocks in a way they didn’t used to be able to — it empowers investors in an entirely new way.

Like most investors, I spend a lot of time on the big news and financial sites daily: The Wall Street Journal, CNBC, Bloomberg, MarketWatch, and as a New Yorker, I love to read the New York Times.

When it comes to doing deeper stock research, I’ve found one of the most underutilized websites is the SEC’s: www.sec.gov.  There’s an entire section devoted to company files and forms — and let me tell you, you can learn a lot from what these companies disclose on these forms. I also like to visit the Investor Relations section of any company’s website. These sections are packed with important information, from earnings to upcoming projects, and so much more.

In my Little Book, I recommend using stock screeners as a good way to help you uncover potential breakout stocks. While there are many stock screeners available to you absolutely free, I have found FINVIZ.com to be one of the most comprehensive, as well as one of the easiest to use. It’s one of my favorites, but if you already use a stock screener other than this one, that’s just fine. The key is that you are using one that you’re comfortable with and can give you the information you need. I’ve set up a website for readers of my Little Book that shows you step-by-step how to screen for low-priced stocks, and so far the feedback has been terrific.

Why do traditional Wall Street research and conventional metrics (such as P/E ratio) not work as well for finding low-priced breakout stocks?

I don’t dismiss those, but you’re right, oftentimes they do not give you the best valuation analysis. It’s because low-priced stocks that are poised to break out are often in extraordinary situations that are about to change dramatically.

For example, I love to look for companies that are on the verge of turning solidly profitable, which can be a great catalyst. But a company not yet reporting a profit can’t be valued on a P/E basis because they don’t have the “E” — earnings. Or, if a company is just turning profitable, earnings may be small, which often produces a higher P/E ratio. If you just look at the P/E, you would immediately say, “Forget it. Overvalued.” But if you know earnings are set to grow rapidly, the valuation analysis completely changes. When looking at low-priced stocks it’s a lot more about the trends that emerge from conventional metrics than the actual metrics themselves.

If the conventional approach doesn’t work, what do you look for when evaluating low-priced stocks?

I dig into every corner of a company’s business looking for at least one catalyst that will cause the stock to break out to much higher prices. These catalysts come in all shapes and sizes — a change in management, a turnaround story that is on the right track, a new product launch that is on the horizon or was just successfully completed, a unique niche product or service that could transform the company’s value, pending regulatory approval, the possibility that a company could be acquired, and so on. I also look closely at a company’s ability to fund its operations, and I like a ratio that calculates earnings (EBITDA)/enterprise value. That’s a good measure of a company’s worth if it were to be sold, and it can help you spot some good bargains.

In the chapter devoted to the biotech industry, you call it an industry overflowing with low-priced stocks.  Why this particular industry?  Will this trend continue for the foreseeable future?

Absolutely! Biotech is a real treasure trove when looking for low-priced stocks. With all of the exciting advancements in health care, there are a lot of companies out there developing potentially breakthrough treatments and therapies for diseases and chronic conditions, but at this developmental stage, they are low on cash and do not yet have revenue. There is a lot of moneymaking potential in the good ones as they either get acquired, partner with a large pharmaceutical company looking for exciting new products, or they actually bring a drug or medical device to market and turn profitable. The bad ones fade away or flame out, so you do have to manage risk by being selective and not overweighting your portfolio in biotech stocks.

But I have to say, I love investigating stocks in this sector. I visit the FDA’s website regularly to keep track of upcoming drug trials and pending approvals. You can get some great investing ideas there, as I have.

You also talk in your book about growing emerging markets as one way to invest in low-priced stocks. What emerging markets are on your radar as we head into 2012?

I really like Brazil and Israel right now. Brazil is full of rich natural resources and has an educated middle class who are consuming more and more goods and services. In Israel, I am especially impressed with the tech and biotech companies, some of which have the potential to be the next Apple or Intel. I was just there and came away impressed with the partnerships between the educational institutions and private sector to develop and invest in new technologies. (See also: 3 Beaten-Down Brazilian Buys)

In the conclusion you argue that investors should be skeptical of the fear-mongering in the financial media and that attractive investment opportunities are always lingering somewhere. As we are wrapping up a historically volatile 2011, can you give us a few reasons why you are optimistic about the equity markets for 2012 and beyond?

I could give you a lot of reasons. The market is cheap on an historical basis. Fear has driven investors into the safety of Treasury bonds, but that bubble is about ready to burst with interest rates so low, and that money will head into stocks. We are probably 75% through the hard part of healing our global financial institutions that are sitting on nonperforming assets. Consumers are spending more again. Earnings have stayed relatively strong, and companies are sitting on record levels of cash. And I would add that I think we will see a flurry of mergers and acquisitions (M&A), which is bullish for stocks and generates excitement and momentum. Companies will start to put all of that cash to work, which will unclog a jammed-up pipeline of deals.

There are obviously concerns about Europe, but this will eventually be resolved, and a lot of stocks can do well even in a global economy that is growing slower than we all would like for a while.

What are some of your favorite low-priced stocks right now?

I like Magic Software (NASDAQ:MGIC), which is what I call in my book, an “Undiscovered Growth” stock.

I was in Israel last week, and I met with some of the high-tech leaders there. Unanimously they all recommended Magic Software, MGIC, which is in the cloud computing business. The stock is almost in half from where it was from its 52-week high, trading just over $6 a share, but the cloud is what is helping companies do their business cheaper, especially companies Magic, in particular, serves — which are large customer-based companies, anything from trading, banking, all the way to the automobile industry. Magic has real cutting-edge technology, because remember, many on-the-go workers are always on their smart phones and/or mobile tablet devices now. So the cloud is essential.

Another stock I like is Office Depot (NYSE:ODP), which is what I call a “Fallen Angel” stock in my book. The company is probably a familiar name to you, thanks to its sizable retail operations in the U.S.

Office Depot was selling for $6 a share six months ago, and today, we can buy this turnaround story in the $2.30 to $2.40 range. The selling intensified in the broader market’s recent volatility on fears of a possible recession, and I really like the stock here at these cheap prices. I believe the odds are we will not have another recession, and the company got a lot leaner and meaner in the last one, so it’s able to weather a slower economy and is poised to break out when the economy strengthens.

For more of my stocks picks, I want to mention that readers of my new Little Book can scan the special codes inside with their mobile devices, or visit the provided website, to get the names of three of my current recommendations instantly.  It’s an interactive feature that makes this unlike other investing books. Folks can go to www.bigprofitsfromsmallstocks.com and click on the Video link to find out more.

Thank you for your time, Hilary, and congratulations on your new book, The Little Book of Big Profits from Small Stocks.

At the time of this writing, Hilary Kramer held shares of MGIC and ODP.